STUDY NOTES - MONETARY POLICY

                                                         RBI & Monetary Policy:

Monetary policy refers to the use of instruments under the control of the central bank to regulate the availability, cost and use of money and credit. The main objectives of monetary policy in India are:

• Maintaining price stability
• Ensuring adequate flow of credit to the productive sectors of the economy to support economic growth
• Financial stability

There are several direct and indirect instruments that are used in the formulation and implementation of monetary policy.

Direct instruments:

• CRR: Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes down. RBI is using this method (increase of CRR rate), to drain out the excessive money from the banks.
• SLR: SLR (Statutory Liquidity Ratio) is the amount a commercial bank needs to maintain in the form of cash, or gold or govt. approved securities (Bonds) before providing credit to its customers. SLR rate is determined and maintained by the RBI (Reserve Bank of India) in order to control the expansion of bank credit. SLR is determined as the percentage of total demand and percentage of time liabilities. Time Liabilities are the liabilities a commercial bank liable to pay to the customers on their anytime demand. SLR is used to control inflation and propel growth. Through SLR rate tuning the money supply in the system can be controlled efficiently.
• Refinance facilities: Sector-specific refinance facilities (e.g., against lending to export sector) provided to banks.

Indirect instruments:

• Bank Rate: Bank rate, also referred to as the discount rate, is the rate of interest which a central bank charges on the loans and advances that it extends to commercial banks and other financial intermediaries. Changes in the bank rate are often used by central banks to control the money supply.
• Repo Rate: Repo rate is the rate at which our banks borrow rupees from RBI. Whenever the banks have any shortage of funds they can borrow it from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases, borrowing from RBI becomes more expensive.
• Reverse Repo Rate: This is exact opposite of Repo rate. Reverse Repo rate is the rate at which Reserve Bank of India (RBI) borrows money from banks. RBI uses this tool when it feels there is too much money floating in the banking system. Banks are always happy to lend money to RBI since their money is in safe hands with a good interest. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to this attractive interest rates.
• Marginal Standing Facility (MSF): Marginal Standing Facility (MSF) is the rate at which scheduled banks could borrow funds overnight from the Reserve Bank of India (RBI) against approved government securities. The basic difference between Repo and MSF scheme is that in MSF banks can use the securities under SLR to get loans from RBI and hence MSF rate is 1% more than repo rate.
• Liquidity Adjustment Facility (LAF): Consists of daily infusion or absorption of liquidity on a repurchase basis, through repo (liquidity injection) and reverse repo (liquidity absorption) auction operations, using government securities as collateral.
• Open Market Operations (OMO): Outright sales/purchases of government securities, in addition to LAF, as a tool to determine the level of liquidity over the medium term.

Post Prepared By Kp

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Classroom Team..